Why the Fed Is Compelled to Lie to Congress

I had an interesting conversation Wednesday about Ben Bernanke's testimony with a person upset over the obvious understatements, spin, and happy talk -- even as the Fed Chair quite soberly discussed the US slowdown.

If the Fed were to come clean about the present circumstances, it would cause a market panic. That's why we get this very gradual shift in assessments, all designed to be somewhat reassuring as it slowly feeds measured dollops of reality into the marketplace.

Wednesday's dovish congressional testimony from Bernanke (and in Vice Chair Don Kohn's speech the day prior) will be continued Thursday. It is as it has always been and always will be.

Why? Imagine if the Fed Chair told the unvarnished truth: The Dow would see a 1,000 point intra-day drop, and that won't help the Fed steer the ship.

Imagine if the Fed fessed up to what we know to be true, and what we suspect the future might bring:

Opening statement of the FOMC Chair, Senate Testimony
February 27, 2008:

Senators, we find ourselves in a very challenging situation.

Following the dot com implosion, my predecessor at the Fed slashed rates to a generational low of 1%; the FOMC then kept rates at 1% for over a year.

While that re-inflated the economy, it also set off a shock wave of inflation unseen since the 1970s. Houses doubled in price, Oil is up 5 fold, food stuffs have tripled, and the dollar has collapsed. Gold is at multi-decade highs.

As always happens, these price increases in hard assets attracted speculators, and that made the situation -- especially in housing -- much more complex. Even worse, the housing speculation contributed to a debacle, while these other assets are actually accelerating in price.

Further, as was the political fashion, deregulation and a lack of interest in the oversight role of the banking system allowed an unprecedented expansion of credit, including to the least credit worthy consumers. Additionally, derivative selling -- at is heart, an unregulated form of insurance -- expanded from a few billion dollars to $46 trillion dollars.

The credit crunch is unprecedented, far worse than the S&L collapse and Long Term Capital Management -- combined.

All of these factors have combined to create our present situation. Inflation remains very elevated and worse, quite sticky. Growth continues to slide towards zero -- and possibly beyond.

Like many others, our forecasts in these areas have been wrong. We expected the slowing economy to moderate inflation, and so far, that has not happened. Demand for commodities from China and India is keeping prices elevated. The weakening dollar -- now at levels last seen in the 1960s -- is forcing all dollar denominated commodities higher. I don't necessarily believe in "Peak Oil," but the fact that the Saudis are one of the world's biggest investors in alternative energy research might tell you something.

The last time a slowing economy failed to moderate prices was the 1970s. Even as the economy slid into recession, we had major spikes in the prices of energy, food, clothing.

What is particularly worrisome to me is that as we have slashed interest rates 225 basis points, consumer loans -- mortgages and revolving credit -- have actually moved higher.

Gentleman, this is a major problem. And our internal, non-public projections forecast it is only going to get worse for the next 4 quarters . . .

Now you understand why the Fed fibs. If they told the full and unvarnished truth, it would be beyond fugly.

Sources:
Semiannual Monetary Policy Report
to the Congress by Chairman Ben S. Bernanke
Before the Committee on Financial Services, U.S. House of Representatives
Federal Reserve, February 27, 2008

The U.S. Economy and Monetary Policy
Vice Chairman Donald L. Kohn at the University of North Carolina at Wilmington, Cameron School of Business' Business Week Program, Wilmington, North Carolina
Federal Reserve, February 26, 2008

Comments

[Britishsteel:]

So basically its ok for bernake to COMMIT PERJURY in front of congress so as not to start a market panic BUT Roger Clemens is being raked over the coals for lying about steriod use. America what a country. What is needed is that all CDO's and SIV"s and any other toxic derivatives be marked to market immediately. If you bought a stock yesterday at 100 bucks and today is worth zero than its worth zero. The feds not going to bail you out, you made a bad decision . I am truly tired of wall street pushing Brenake to socialize the risk and privatize the profits. This whole Bull rally these past 6 years has been built on smoke and mirrors and those who participated and aided and abetted this ponzi scam should be made to lose what they have lost and be prosectued to the fullest extent of the law.

2008 Feb 28 04:51 PM

[fjd10595:]

That is well stated, and I think a very accurate assessment of the economic situation. It is the reason that stocks cannot be higher one or two years out. It is impossible. Earnings are destined to slow.

2008 Feb 28 07:04 PM

[Britishsteel:]

Well thank you very much for your kind words . if you agree as you say you do please follow the link I am posting and sign the online petition and also follow up with a letter to you congressman . Its for our childrens future.
financialpetition.org/...

2008 Feb 28 09:53 PM

[markg:]

Will the mortgage company and bank bailout have a condition that any executive officer that worked at these companies return all bonuses paid in the last 4 years?

2008 Feb 29 02:38 AM

[ballsschweaty:]

With a 2 yr treasury yielding 1.7%, we will see money velocity substantially rise and the economy will be much stronger than most think.

There are 2 ways of driving growth in the economy. Credit growth is one way and we won't see that happen anytime soon.

The other way is for money velocity to rise. With $11 trillion of m-3 earning an average 2% per annum, we will see money become a hot potato. If velocity picks up just 10%, that's an added $1 trillion per year in gdp.

Those predicting a deflationary debt collapse are just plain wrong. We will see people spend money big time rather than just sit on it and watch the purchasing power go up in smoke.

2008 Feb 29 11:29 AM

[David Roskoph:]

Our function as American citizens has been reduced to mindless consumers. The sales seduction has reached its apex and now we have the result, soaring bankrupsies. If the public understood the numbers that describe our balance sheet, they'd do what they should and live within their means. If there were any adults in our government who truly cared about our strength as a nation, they'd advocate responsible personal finance, not bing buying with any windfall. What a pipedream that has become.

2008 Feb 29 02:31 PM

[pochovilla:]

Well Barry:
His choice was water boarding in Guantanamo or believing what he said is true ,in the long run, with caveats ...and the right to change his mind based on new evidence in the data with certain minor adjustments. Get the point mate ?

2008 Feb 29 03:49 PM

[Britishsteel:]

to ballsshweaty : your quote was:
The other way is for money velocity to rise. With $11 trillion of m-3 earning an average 2% per annum, we will see money become a hot potato. If velocity picks up just 10%, that's an added $1 trillion per year in gdp.

how do you know what the M3 number is if it is no longer available for public view? where did your get your figures from? also you said IF and IF that figure is correct that you are basing it on . My question to you is besides where the figures come from is: If all were well with our banking system why did citi borrow from the Arabs at 14%
when they could have gone to the discount window for 3.75%? and as you know when the overnite rates was 5.75% 30 YEAR FIXED WAS 4.65% AND AT 3.00% 30 YEAR FIXED IS OVER 6% SO IS LOWERING THE OVERNITE RATE HELPING THE AVG CONSUMER OR IS IT JUST BAILING OUT BANKS AND WALL STREET? Seems like credit is getting more expensive if you ask me and I know you didn't but well there ya go. Also here in NY the Port Authority tried to auction off bonds and recieved no bids. The last on the interest rate was 20% and no one wanted them? why? and now they are asking to be allowed to buy their own bonds so the interest rate does not ramp higher? Does that sound like a good thing to you? It seems everwhere you turn Bernakes is breaking rules to stave off deflation like granting exemptions from those borrowing from the discount window I think 4 or 5 banks got 23A exemptions which allow them to extend the time they wer supposed to pay the money back within. Just does not smell right and seems to be collusion and deception being practiced on a regular basis . And what about uncle Bendover on OPTIONS EXPIRATION IN AUGUST AFTER THAT HUGE DOWN DAY ON THE 17TH HE LETS SLIP THAT RATES WILL BE LOWERED ALL THE BIG WALL STREET FIRMS GO LONG RIGHT BEFORE THE BELL AND THEN THE NEXT DAY HE SCREWED ALL THE SHORTS AND LOWERED RATES AFTER ALL THE BIG GUYS WERE IN POSITION TO BE LONG? IS THAT A TRANSPARENT SYSTEM? AND THE FACT THAT PAULSON WAS THE FORMER GOLDMAN HEAD AND NOW SECRATARY OF THE TREASURY? AND HE IS CONSTANTLY IN TOUCH WITH THE PRESIDENTS WORKING GROUP ON THE MARKETS?
SOUNDS LIKE A CONFLICT OF INTEREST TO ME.

2008 Feb 29 08:16 PM

[jcrash:]

British, the problem with "If you bought a stock yesterday at 100 bucks and today is worth zero than its worth zero" and comparing that to credit is that credit is an income stream and the current market is saying the value of that credit is worth less than the stream - even though the stream has not been interrupted.

This would basically be like your car note holder coming to you and saying YOUR car is worth less now, so we need you to come up with the change in value NOW...even though you haven't missed a payment and are still using it and it is in great condition.

This is a crisis of CONFIDENCE, not of value. The value is there, but confidence is low and marking it to MARKET of low confidence makes as much money as selling your stocks only when they go down.

Obviously, the low rates is better for banks than it is consumers - they are on the direct receiving end of it. They are sucking up the delta to make money. In the end, this should make the banks immensely more valuable than they are today.

2008 Mar 03 12:48 PM

[Britishsteel:]

actually the stream has been interrupted has it not? If you look at the 23A exemtions that have been granted to certain banks and the fact that liquidity has been injected by the FED to keep solvency and to try to push banks to lend to each other because they do trust each other because the LACK OF TRANSPARENCY leads to a lack of trust! And this has led banks like citi to go to soverign wealth funds to borrrow at loan shark rates to keep trhem from having to show this transparency! If the credit income stream was flowing as you stae then why did citi borrow from Dubai at 14% interest when they cpould have borrowed from the discount window at 3.75%?

2008 Mar 04 09:34 AM